The management of any company has two key groups to satisfy. The first is customers. If your customers are not satisfied, they stop buying your product. The second group is owners (shareholders, co-op members, family, etc). If this group is not satisfied, management is replaced or the business is sold or even shut down. Dissatisfaction on the part of either of these groups is a major pain for management.
To improve the satisfaction of either of these groups, we need to measure that satisfaction. As an old management saying goes, if you do not measure it, you cannot improve it. For customers, some measure of customer satisfaction—a method of determining the score—needs to be in place. For owners, the traditional measurement is profit, the return due the owners.
But these two groups and their measurements are connected and therefore must be balanced. Most things that will improve customer satisfaction will, in the short run, hurt profitability. If we are suffering too many out-of-stocks, we will want to increase inventory levels, but that means more working capital and added expenses in insurance, perhaps outside storage, etc. Funding for the additional inventory comes from profit. If the owners are demanding a greater return, the easy way to provide it is to cut expenses, maybe lowering the investment in research and development (R&D) or sales expenses, both of which have a negative impact on customer satisfaction in the short or long term, or both. But in the long term, decreasing out-of-stocks means greater customer satisfaction and, we hope, customer loyalty and increased revenue.
Measuring Customer Satisfaction: The Perfect Order Index
How do we measure customer satisfaction? Some people measure it from sales data; if sales are increasing, the customers must be happy. While important to profitability, it does not measure customer satisfaction. Many extraneous factors impact sales that are unrelated to how well you are doing at customer satisfaction. Maybe a competitor is much worse than you are—if they improve, or if a new competitor appears, you will lose that business due to your lack of customer satisfaction. Maybe you have a great product and customers will buy it even if they are not satisfied with you as a supplier. If an alternative product—the same or better than yours—appears, you will lose that business. No, measuring satisfaction with sales data is not meaningful, and it can even be misleading.
To understand customer satisfaction, we need to evaluate many things. Are they happy with your promotional efforts, your new product introduction efforts, your pricing, etc? But the number one issue is simply: is your product reliably on your customers’ shelves? We cannot see their shelves but we can measure the effectiveness of our ability to provide the product. While many alternative ways exist to measure the effectiveness, allow me to suggest the ultimate measurement: the perfect order. A simple definition of the perfect order is an order where the customer has no reason to be dissatisfied. An alternate definition is an order where 100% of your various business processes work perfectly.
How do we succeed in creating a perfect order? Many business processes are involved in the life cycle of an order, from capturing the order (order entry) to collecting the resulting receivable. If any of these business processes fails, the order is not perfect and the customer’s satisfaction is impacted. If one line item is not correctly picked, if one discount is not correctly calculated, if the invoice is not in the form expected, the order is not perfect. Note that collection is part of the definition of a perfect order. If the customer does not pay what is invoiced, on time, that indicates a situation where the customer is not satisfied. Operational excellence is the key to perfect orders and therefore the key to customer satisfaction.
Defining the Perfect Order Index
There is no single way to calculate the perfect order. Different sources show different math. All of the calculations work on the assumption that the perfect order is the culmination of other measurements that focus on the quality of the various business processes. The perfect order is most typically defined as being delivered on time, complete, damage free, and having the correct invoice. These lower-level metrics are measured as percentages—for example, the percentage of orders that are shipped complete. One way to define the perfect order index is given below:
In our example, if a company scores at 95% for each of the four metrics, the resulting perfect order index is 81.4%.
The perfect order index and the lower-level metrics (on time, complete, etc) serve two purposes. First, the metrics allow us identify areas for improvement and measure the progress of our efforts. Second, and perhaps more importantly, these lower level metrics serve as a diagnostic tool to evaluate the business processes in an effort to improve them. Although we like to know that we are 98% on time, what we really need to understand is why we are not on time 2% of the time. Always remember, metrics have two objectives: to measure success and analyze failure in an effort to eliminate failure and thereby increase success.
The Perfect Order and Profitability
Procter& Gamble defines a perfect order as a product that arrives on time, complete (as ordered), and billed correctly. P&G discovered that each time it shipped an “imperfect order,” the cost was an average of $200. The company found it was incurring such unnecessary costs as the cost of redelivery when orders were late, replacement costs if shipments were damaged, and processing costs for quantity adjustments, as well as price and allowance deductions.
How are shareholder value and the perfect order connected? Benchmarking studies conducted by AMR Research show a correlation between improved perfect order performance (using an index similar to the one defined above) and overall corporate results. The research shows that raising the perfect order score by 5 percentage points results in a 2.5% improvement in return on assets. A 3% improvement in the perfect order score correlates with a 1% increase in profit margin, and a 2% jump in the perfect order score shows a 10-cent increase in earnings per share.
To Improve the Metrics, Improve the Business Processes
Improving the customer service metrics will have an impact on profitability. While customer service improvements are vital to success, we need to have a clear understanding of the financial impact. For example, more than one improvement project may be identified, but it may not be practical to undertake more than one project at a time. Will a project increase revenue, or will it require additional expense or increased working capital? Often a project has a variety of impacts. What we need is an understanding of the value of improvements.
Having the desire to improve is great, but what is the path to improvement? Customer service improvements come from increasing the effectiveness of business processes. To improve a metric (for example, damage-free deliveries), the business processes that impact the metric must be identified. The path to improvement also tells us what the best practices are to improve (in this case, damage-free delivery).
Summary
Manufacturers and distributors must keep two groups satisfied—customers and owners. The satisfaction of these two groups is connected—what improves the satisfaction of one group can impact the satisfaction of the other. Only through measuring the satisfaction of both groups can these sometime conflicting groups be balanced. Owners watch earnings and return on investment. Customer satisfaction demands a number of measurements, one of which is the perfect order.
About the Author
Olin Thompson is a principal of Process ERP Partners. He has more than 35 years’ experience as an executive in the software industry with a focus in process industry–related ERP, SCP, and e-business–related segments. Olin has been called “the father of process ERP.” He is a frequent author and an award-winning speaker on topics of gaining value, including ERP, SCP, e-commerce, and the impact of technology on industry. He currently provides consulting services to both end user and supplier organizations. He can be reached at OT@Process-ERP.com.